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2 Abstract Today companies need and seek to optimize any of its operations. IT is one of the operations which is often sought optimized by outsourcing, and the main drivers for IT outsourcing are cost reductions and improved operations to be able to focus more on core-business. This dissertation investigates whether global research and findings in IT outsourcing can be transferred to SMEs in particular SMEs in Denmark. Some of the questions it seeks to answer are: What can be learned from the Global Enterprises having used IT outsourcing strategically for over 4 decades? Can SMEs benefit strategically and economically from outsourcing its IT operations? What types of IT outsourcing are the most successful in SMEs? There has been a lot of research made in the IT outsourcing area within the last two decades, but most of this research has been made in large Global Enterprises. This dissertation focused on comparing global research data with local research made in Denmark using online questionnaires collecting quantitative data from 141 SMEs in different industries. The answers were followed-up by in-depth interviews with some of the companies. It was concluded that IT outsourcing gives SMEs better IT operations and services, and that SMEs are more focused if they have outsourced some or more of their IT operations. Selective outsourcing is by far the most used and successful IT Page 2 of 92

3 outsourcing model, and web, mail and application hosting the most used and successful types of outsourced IT operations. SMEs seldom use Frameworks or Best Practice guidelines when planning or implementing IT outsourcing, because they often don t have dedicated IT personnel. IT is in general handled on an ad-hoc basis in most SMEs in Denmark. Even though IT is rarely handled on a strategic and structured level, most SMEs are successful with their IT outsourcing solutions as IT in most SMEs is very standardised and seldom very complex. Acknowledgements Thanks to the companies and people who took the time to answer my questionnaire and take part in the interviews. I would also like to thank my advisor at Henley, Peter Woolcock for his advice and guidance during the dissertation process and thanks to everyone at Henley Denmark, especially Leif and Sven for motivation. Last but not least, my love and thanks to Charlotte Christensson, who struggled with her own MBA dissertation and kept me writing! Page 3 of 92

4 Table of contents: Abstract... 2 Acknowledgements... 3 Table of contents: Introduction Objectives Primary Employer Personal Academic Industry definition Relevance and importance Dissertation outline Literature review Literature review introduction Global trends of IT outsourcing drivers Global Trends of IT Outsourcing Models IT Outsourcing Types What can be outsourced? Global Trends of IT Outsourcing Types IT Outsourcing Frameworks Conclusion Research Method Research Introduction Research Questions Research Design and Strategy Research Findings Danish SMEs Trends of IT Outsourcing Drivers Danish SMEs Trends of IT Outsourcing Models IT Outsourcing Types in Danish SMEs What can be outsourced? Danish SMEs Trends of IT Outsourcing Types Page 4 of 92

5 4.5 Danish SMEs Use of IT Outsourcing Frameworks Research Conclusion Analysis and Conclusions IT Outsourcing Drivers IT Outsourcing Models IT Outsourcing Types IT Outsourcing Frameworks Recommendations Limitations of the research and findings Suggestions for further research A reflection on the initial learning objectives References: Appendix Appendix 1 Questionnaire Appendix 2 Additional Interview Questions Appendix 3 - TCO Analysis Appendix 4 Analysis of the Danish Outsourcing Provider Market Page 5 of 92

6 1. Introduction According to Ahorlu (2002) IT in small and medium-sized enterprises (SMEs) today, is often handled on an ad-hoc basis. In these companies there is often no dedicated person responsible for managing information systems, nor for developing systems to fit business needs or to service employees when problems occur. In Denmark the current economic situation (2009) is heavily influenced by the Global Financial Crisis. Companies seek to free or save resources and costs by outsourcing central functions as IT, Finance, HR and Production etc. Until recent years, IT outsourcing was a service reserved for large companies and public institutions only. New and improved technologies and services now make it possible for even the smallest companies to outsource their IT solutions completely. Today it is possible to rent everything from hosted IT systems to business software on a monthly basis including security and backup services via the internet. IT solutions have become virtual, and this enables small and medium-sized businesses to save significant time and money on running their own IT platform. Ahorlu (2002) performed a survey among 300 Nordic CIOs whereof approx 100 worked in SMEs. The report concluded that IT outsourcing is suitable for companies of any size. Page 6 of 92

7 (Figure 1: 2007 IT Outsourcing Statistics from Statistics Denmark) Figure 1 illustrates the results from a recent survey made by Statistics Denmark (2007) 5168 SMEs participated in the survey. It reveals that almost 23% of companies with employees have outsourced their IT operations and/or telecommunications. In businesses with more than 50 employees the rate is 29%. According to an IDC Nordic analysis (2007), the IT outsourcing business in Denmark is growing with a rate of around 20% per year! IDC also concluded that: Few new mega-deals will be signed Companies that already partially outsource are ready for enhancements, whereas first-timers are more reluctant Medium-sized and small companies are starting to outsource, and these companies often go for full IT outsourcing in one step Security outsourcing, IP telephony hosting, and ERP hosting grow rapidly in companies of all sizes Page 7 of 92

8 1.1 Objectives Primary The primary objective of this report is to investigate whether and to what extend Danish SMEs can benefit from IT-outsourcing. The report will investigate the level and benefits of IT outsourcing in SMEs in Denmark compared to global trends. It will review the global IT outsourcing trends. What are the most common practices in IT outsourcing? And what are the most successful types of IT outsourcing? A local research will then investigate the Danish SME market - what are the trends here? And do they get the same benefits/problems as larger global organizations? (a complete list of sub-questions are listed in chapter 3). Conclusion should identify whether SMEs can gain the same benefits by outsourcing specific areas of their IT as larger international enterprises. What areas of IT outsourcing is the most used and most successful in SMEs in Denmark, and what can be improved by the way they are doing it, and the way the providers are offering the services. Recommendations will hopefully guide SMEs to decide whether they can gain business advantages by IT outsourcing, and what types to choose based on the research. Page 8 of 92

9 1.1.2 Employer My employer is an IT outsourcing provider in the Danish market. The company went public in 2007, and is growing heavily via acquisitions in both Denmark and the Nordic Region. This report will help the company understand the market and customer needs better. Research will also question what vendors can do better Personal Both literature review and research will give me better insight into the IT outsourcing business and help me understand the market and customer needs better. This should enable me to design better products and services for the company and our customers, and hence hopefully give us a competitive advantage. I also expect to improve my research skills significantly using proven research methods Academic There is a great amount of literature and research within the global IT outsourcing field, however, according to my research, there is only very little academic research and literature investigating IT outsourcing for SMEs. Most research is done within global enterprises and on global mega-deals. This research should lead to a better understanding of IT outsourcing in SMEs, the key advantages in particular, but also identify pitfalls. Page 9 of 92

10 1.2 Industry definition According to NNerhverv (2008), Denmark has 19,930 small and medium-sized enterprises. According to the European Commission (2003), SMEs are defined as businesses with employees. According to The Free Dictionary (2008), the global definition is mainly defined as businesses with employees with upper limit ranges to 5,000. In total there are 188,346 businesses registered in Denmark (2009) or one per 29 inhabitants. Statistics Denmark (2008) reports a total number of 5,475,000 people in Denmark. 1.3 Relevance and importance As the financial situation in Denmark is heavily influenced by the Global Financial Crisis, SMEs investigate to increase their productivity by outsourcing non-core business functions as IT, finance, production etc. to cut costs and to free up internal resources for core-business functions. According to global academic research made by Lacity et al (2000), organizations can benefit from outsourcing IT functions that are not strategic to its business. Research has mainly been done in larger organizations (+500 employees). This research will focus on SMEs in Denmark with employees. Research should identify whether and to what extend Danish SMEs can benefit from IT outsourcing. Page 10 of 92

11 1.4 Dissertation outline Chapter 2 covers the literature review, which will summarize global trends in IT outsourcing. The review mainly focuses on research made in larger global organizations but it also includes a few research papers made in the Nordic region (Denmark, Norway and Sweden). Conclusions from the global review will build research questions to investigate in Danish SMEs and to finally compare global IT outsourcing trends from larger organizations with Danish SMEs. Chapter 3 starts with the scope of the local research including research questions, design and strategy. Chapter 4 presents the research findings followed by analysis and conclusions in Chapter 5. Chapter 6 presents the final conclusions and recommendations. Page 11 of 92

12 2 Literature review 2.1 Literature review introduction Outsourcing is not a threat to this nation s economy it s an opportunity to raise American paychecks, productivity, and prosperity. It s an opportunity we will squander, if we let the alarmists stampede us into boneheaded solutions. - John Castellani, President of the Business Roundtable to the Detroit Press Club, February 24, 2004 Brown et al (2005) This literature review will analyze global trends in IT outsourcing. Even though most of the reviewed literature is based on research from large organizations, Brown and Wilson (2005) states that outsourcing is no longer of advantage only to big companies. As more companies become involved in outsourcing, opportunities are opening up to owners of small companies. Smaller companies have the same goal as big companies: to earn more while spending less. This is supported by Ahorlu and IDC (2002) who also conclude that outsourcing is for companies of all sizes, and that small companies get an IT advantage by outsourcing IT installation, operations and service due to the standardisation. Hereby, smaller companies reduce their vulnerability caused by limited resources. Before we move on to the actual review, let us define outsourcing in general. Browne and Wilson (2005) define outsourcing as the practice of hiring private contractors that are not necessarily based in another country, to handle projects for a company. Page 12 of 92

13 Bendor-Samuel (2000) states that outsourcing involves the transfer of the management and/or day-to-day execution of an entire business function to an external provider. Ventureoutsource.com (2007) defines outsourcing as subcontracting a process, such as product design or manufacturing, to a third-party company. There are a lot of research papers dealing with IT outsourcing, and many are based on empirical analysis. A few have also been made within the Nordic SME market; however they only scratch the surface of this large and developing topic. The literature review presented here will first look at some of the drivers for companies to consider IT outsourcing. Hereafter some of the advantages and disadvantages in IT outsourcing will be highlighted, followed by a review of the most common sourcing models. The review will summarize global findings on the most and least successful types of IT outsourcing and end with a review of some of the theoretical frameworks produced, including characteristics of successful outsourcing deals. 2.2 Global trends of IT outsourcing drivers Hall (2008) states that in the future, most companies will no longer have or run their own IT infrastructure, including data centers it is simply no longer of strategic importance to most companies to build and maintain their own IT infrastructure. Hall (2008) explains that today, the development of on-demand IT services and software has come so far, that most common standard IT services such as office products, hosting, mail, web and application hosting can be rented easily, effortlessly and at very competitive prices over the Internet. The development of software as a service products Page 13 of 92

14 as well as the easy outsourcing of server operations via the Internet are some of the primary drivers for companies to choose IT outsourcing instead of installing and maintaining their own applications and IT infrastructure. Research performed by IDC and Ahorlu (2002/2007) in a mix of larger enterprises and SMEs concludes that outsourcing does not give companies significant cost reductions, but it provides overview and the possibility to place IT as a business service. Technology and stability will end up being more important than the economic argument for outsourcing. This, however, does not change the fact that global research, including the following, identifies cost reductions as one of the most important drivers for IT outsourcing. Robin Sood (2005) identifies some of the main reasons for IT Outsourcing as: Staffing Cost Reduction identified as the most common advantage and usually thought to be the most important. Today, lower wages and high flexibility can be found in countries like India, Bangladesh, Mexico and China. Operating Cost Reduction - Vendors are able to work with a lower cost structure as a result of greater economy of scales, e.g. one data center for thousands of customers sharing the same IT infrastructure. Hereby lower and fixed prices for IT operations can be achieved. Company Focus Improvement Outsourcing allows an organization to focus its resources on the core activities without having to worry about the non-core activities. Many vendors use this as the main USP for marketing their IT outsourcing services. Page 14 of 92

15 Flexibility Delivery of products and solutions is directly dependent on the number of organizations employees who are able to contribute to the goal. In specific situations it can boost performance to outsource specific short term tasks as for example the development of a new ERP system. Reduced Time to Market Some IT related tasks as development can take up a lot of time, delaying products or improved services etc. Outsourcing can reduce Time to Market and move development forward much faster. Access to Specialist Skills Instead of hiring expensive and hard-to-find specialists, outsourcing can give companies access to vendor specialists as needed. Risk Mitigation or Risk Sharing Vendors offer deals where they guarantee delivery dates or pay even large penalties by delays and also guarantee up-times of hosted servers etc. As it is almost impossible to punish your own IT department except firing them - this is often a good argument for outsourcing. All Major Companies are Doing IT! There must be a good reason for the major companies or one s competitors to outsource IT. Instead of using a lot of internal energy analyzing the pros and cons of IT outsourcing, some companies often choose to outsource because it seems like the right thing to do! Page 15 of 92

16 Using World-Class Resources Larger vendors offer access to specialists with in-depth knowledge of particular technology or business domains. This is very difficult and expensive to achieve and maintain inside a normal organization. Quality Improvement By outsourcing, companies can improve quality and internal processes. Larger vendors have focus on streamlining and optimizing processes and quality, and companies can benefit from the process of outsourcing learning from vendors who have collected experience from a variety of companies. Effective Management outsourcing should reduce companies in-house resources, including the management resources requirements. Greaver (1999) divides the main reasons into the following 7 categories: Organizationally Driven Reasons Focus on what you do best. Improvement-Driven Reasons Improve operational and management performance. Financially Driven Reasons Free up cash resources - transfer assets. Revenue-Driven Reasons Gain market access and business opportunities through the providers network. Cost-Driven Reasons Reduce costs through superior provider performance and the provider s low cost structure. Turn fixed costs into variable costs. Employee-Driven Reasons - Increase commitment and energy in non-core areas. Page 16 of 92

17 These are very similar to Smith et al (1998) findings that classify the main drivers into 5 categories: cost reduction, focus on core competencies, liquidity needs, IT capabilities and environmental factors. In addition, The Outsourcing Institute (1998) identified and analyzed the top 10 reasons (in alphabetical order) for outsourcing as: 1. Accelerate re-engineering benefits 2. Access to world-class capabilities 3. Cash infusion 4. Free resources for other purposes 5. Function difficult to manage or out of control 6. Improve company focus 7. Make capital funds available 8. Reduce operating costs 9. Reduce risk 10. Resources not available internally It is important to mention that these findings were done mainly via research in larger global organizations. Along with these drivers and reasons Welch and Nayak (1992) summarise the following key benefits of outsourcing: 1. It allows fixed costs to be converted to variable costs, providing flexibility in case of economic downturn (as we experienced during the 2008/2009 global financial crisis). Page 17 of 92

18 2. Outsourcing helps balance work force requirements. 3. Outsourcing reduces capital investment requirements. 4. Outsourcing reduces costs via suppliers economies of scale and lower wage structures. 5. Outsourcing accelerates new product development. 6. By outsourcing, organizations gain access to invention and innovation from suppliers. 7. Outsourcing allows firms to focus resources on high value-added activities. In addition to these benefits, King (2004) also argues that outsourcing itself gives an organization greater awareness of the benefits of outsourcing. A driver can therefore be defined as the learning process optimizing a company s business processes. Bocij et al (2006) summarized the following reasons given by companies as to why they use outsourcing: Reason Cost savings Improved quality of service Access to specialist expertise Increased flexibility Strategic business decision Free management time Lack of resources Improved financial control (Table 1 Main reasons for outsourcing) Percentage mentioning 57% 40% 37% 27% 21% 19% 11% 8% Some of the most productive researchers in IT outsourcing, Lacity and Wilcocks (1998), studied 61 sourcing decisions. Cost reduction was the most prevalent (80%), Page 18 of 92

19 followed by service improvements (59%). A survey of 48 US companies on Computerworld s Premier 100 list investigated by Lacity and Willcocks (2001), revealed that 90% expected to save money with their sourcing decisions. Other important expectations included reduced need to hire IT professionals, improved cost predictability and improved focus on strategic use of IT. These expectations are very similar to the findings by Sobol and Apte (1995) that identified seven benefits likely by IT outsourcing, among them improved cost predictability and the reduced need to hire IT professionals. Deloitte Consulting Group (1998) made a survey among global Chief Information Executives that seems to suggest, that what are perceived as the desired benefits of outsourcing often turn out to be the biggest disappointments, suggesting that in many, but not all, cases, outsourcing fails to deliver the anticipated effects. Table 2 below illustrates their findings: Objective % who perceived as most desired benefits of outsourcing % who perceived as greatest disappointment of outsourcing Cost reduction 33% Transition to new technology 41% Improved quality 47% Focus on core competencies 49% Supplier expertise 52% (Table 2 Summary of perceptions of outsourcing, Deloitte Consulting Group, 1998) 59% 42% 51% 41% 59% The global trends can be summarized from the above mentioned findings and research. Page 19 of 92

20 Cost reduction, improved quality and access to expert knowledge seem to be the most common drivers for companies to choose IT outsourcing. Cost reduction is however seldom achieved at the desired level, but in general it is concluded that most companies gain improved quality (and/or IT operations in general) by outsourcing specific IT operations. Most research concludes that companies are able to focus on core competencies as an effect of outsourcing IT operations. 2.3 Global Trends of IT Outsourcing Models Along with the development of new IT outsourcing services and products, a wide array of outsourcing terminology has come to life. Lacity & Wilcocks (2001) summarize the following outsourcing models: Selective Outsourcing only part of the total IT solution is outsourced, and strategic management is often kept in-house. Transitional Outsourcing the practice to temporarily outsource during a major transition to a new technology. Total Outsourcing complete outsourcing of all IT systems, development and operations including strategic management. Value-Added Outsourcing vendor and outsourcer combining strengths to market IT products or services, or develop mutually beneficial business improvements. Page 20 of 92

21 Equity-Holding Deals some customers and suppliers have signed deals including taking ownership in each other s companies to mutually benefit from developments and finding (best practices) by selling end-solutions to others in the industry. Multi-Sourcing one contract, multiple suppliers (also investigated heavily by Cohen and Young, 2006). Offshore Outsourcing leveraging price advantages and skill and performance resources abroad. Co-Sourcing performance-based contracts. The outsourcing contracts are based on reaching overall business objectives, and pricing is based on the results r overall performance of the outsourcer. Business Process Outsourcing outsource a process and its IT, identified as non-core e.g. billing or customer support. Spin-Off s spin-off successful IT functions into independent companies. In Denmark several large companies have transformed their internal IT department into an external entity, e.g. the large pharmaceutical company Novo Nordisk made a very successful spin-off of its IT department into the independent IT Company NNIT, who today is a large service provider for other companies in the Page 21 of 92

22 business. Cohen and Young (2006) premise that outsourcing works, and that the key to success lies in the move beyond multi-sourcing. Multi-sourcing, which they define as the optimum blend of internal and external providers of business services in line with companies' strategic vision and goals, presents any company with a sophisticated playbook for success. In contradiction to Cohen and Young (2006), Lacity and Willcocks (2001) make the assessment on multi-sourcing, that the risk of going with a single supplier is mitigated but replaced to a degree by additional time and resources required to manage multiple suppliers. Lacity and Willcocks (2001) make the assessment that most companies are successful with their selective and transitional outsourcing. They also find that most companies often re-negotiate (or terminate) fixed-price, exchange-based, long-term contracts. This applies especially to total outsourcing deals. Willcocks and Feeney (1998) also found that selective outsourcing generally achieved expected cost savings more frequently than all-or-nothing approaches, and that selective outsourcing helped to overcome the problem where vendors or internal IT departments do not have all the expertise needed to perform all IT tasks most efficiently. Peynot (2006) states that IT outsourcing decisions seldom result from an enterpriselevel vision, but rather from opportunistic corporate behavior. To make better and more Page 22 of 92

23 strategic decisions, service buyers need reference points, like systematic outsourcing models. Cullen and Willcocks (2003) have produced such systematic outsourcing models eight building blocks to successful IT outsourcing, which are reviewed in subsection 2.6. Ahornu and IDC (2002) surveyed 300 SMEs and found that surprisingly many companies used more than 2 outsourcing partners (Figure 2 below). Only 26% have a single supplier, which is either a webhosting supplier or a systems supplier. Often companies have 2 partners one for webhosting and one for systems outsourcing. But surprisingly 47% have more than 2 outsourcing partners. These are companies also using ASP (application service providers) and external security providers for SPAM, virus and/or network security. Half of the companies believe it would be advantageous to have only one supplier, while only 25% actually have limited it to one. (Figure 2, Number of outsourcing partners in SMEs, IDC 2002) IDC (2006) and Lacity et al (2001) both conclude that total outsourcing is risky and difficult to manage. Also only a few suppliers have the required skills to offer complete Page 23 of 92

24 outsourcing solutions, and companies seldom have the internal resources for handling large complex contracts. According to Lacity et al (2001), some of the problems encountered with total outsourcing contracts are: Excess fees for services beyond the contract, or excess fees for services customers assumed were in the contract. Fixed prices that exceeded market value over the long term. Failure to improve service levels or declining service levels, primarily due to poor contractual definition of service levels, or a lack of user understanding of the contract. Inability to adapt the contracts to changing business and technology needs. Loss of power due to a monopoly supplier condition. Inability of the customer to manage the user/suppler interface. Reviewing some of the IT outsourcing mega-deals including Enron/EDS, First Union/EDS, LSI Logic/IBM, Xerox/EDS concludes that many deals are often renegotiated or early terminated. The literature review concludes that selective outsourcing is generally successful. Total outsourcing, especially to minimize the number of suppliers, is wanted by many companies, but seldom successful. 2.4 IT Outsourcing Types What can be outsourced? As reviewed in part 2.3, there are different degrees of outsourcing, varying from total outsourcing to partial management of services. This subsection will introduce the main Page 24 of 92

25 categories of services that can be outsourced. According to Bocoj et al (2006) the main categories can be defined as: Hardware Outsourcing. This may involve renting time on a high-capacity mainframe computer. Effectively, companies are sharing the expenses of purchasing and maintaining the network with other companies that are also signed up to an outsourcing contract. This is also known as a time-sharing contract. Network Management. Network management may also be involved when managing hardware: here a third party is responsible for maintaining the network. This is often referred to as facility management (FM), and may also include management of PC and server hardware. Outsourcing Systems Development. Developing and modifying software to fit business needs and processes. This is often outsourced to external experts, and in recent years countries as India and China have specialized in delivering these services at low costs, also known as offshoring. IS Support. This includes outsourcing a company help desk covering answering queries about operating systems, office applications or specific company applications. It may also include fixing problems on-site or remotely. Page 25 of 92

26 Management of IS Strategy. Determining and executing the information systems strategy is less common than other types of outsourcing outlined above, because many companies want to retain this control. A great deal of trust is placed in the outsourcing partner, and it is most common in a total outsourcing contract. Total Outsourcing. Contracts typically involving all of the above. The complete responsibility is placed by one or more outsourcing partners including IS strategy etc. Cullen et al (2003) divide the main types into 4 groups with the following sub-groups: Mainframe and Data Centers Operations o o o o o o o Hardware support and maintenance Systems implementation Applications development Applications support and maintenance Systems integration Operations and facilities management Disaster recovery Client/Server and Desktop o o o Hardware support and maintenance Systems implementation Applications development Page 26 of 92

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